Business Finance Flashcards

Net present value (NPV) is considered superior to the payback period method because:

Answer: It considers the time value of money and all cash flows over the project's life

NPV accounts for the time value of money by discounting all cash flows, considers the full life of the project, and measures value creation in absolute monetary terms.

The dividend growth model values a share as:

Answer: Next year's expected dividend divided by (cost of equity minus growth rate)

The Gordon Growth Model (dividend growth model) calculates share price as D1 / (Ke - g), where D1 is the next dividend, Ke is the required return, and g is the constant growth rate.

Financial gearing measures:

Answer: The ratio of debt to equity (or total capital)

Gearing measures the proportion of debt in a company's capital structure relative to equity or total capital. Higher gearing means more financial risk due to fixed interest obligations.

Which source of finance is typically the cheapest for a company?

Answer: Debt (secured loan)

Secured debt is typically the cheapest source of finance because lenders have security over assets, reducing their risk; interest is also tax-deductible, further lowering the effective cost.

A company's cash conversion cycle is the average time between:

Answer: Paying for inventory and receiving cash from customers

The cash conversion cycle = inventory days + receivables days − payables days. It measures how long cash is tied up in the operating cycle before being recovered from customers.

Under the capital asset pricing model (CAPM), beta measures:

Answer: The systematic (market) risk of an investment relative to the market

Beta measures systematic risk — the sensitivity of a security's returns to movements in the overall market. Unsystematic risk can be diversified away; only systematic risk is rewarded in CAPM.